Government and private sector clients are pressurising contractors to make big savings on projects. Often that means just pushing the pain down the supply chain. Can specialists get by on smaller and smaller rations?

Life has rarely been so hard at the bottom of the supply chain. As the market once again shows signs of seizing up, hard-up clients are passing cuts down the line. This month it emerged that Carillion has been renegotiating existing contracts with suppliers for discounts of up to 20%. Building has now obtained details of how Carillion went about the cuts, and subcontractors have spoken out about other main contractors attempting to renegotiate for reduced rates, endangering already wafer-thin margins. Some firms are asking for discounts on private sector work as well as public.

This aggressive pricing has arrived just as clients are ratcheting up the pressure on contractors to cut rates. So, with materials prices rising fast and research showing the number of construction firms in danger up a fifth in the last three months of last year, the question is whether specialists can survive on such meagre rations.

Carillion hit the press this month when it cut prices. The contractor is aiming to slash its supplier base from 25,000 companies to 5,000 in an attempt to save £140m by 2013.

It began a company-wide review of its preferred suppliers last year. As part of the review, suppliers were required to enter into eBay-style timed bidding wars for a place on the firm’s preferred suppliers list. Under the system, firms enter into an online form the discounts they are prepared to make on their work relative to the turnover of work received from Carillion. They are then ranked against other bidding suppliers.

The firms and their proposed discounts are hidden from each other, with companies presented simply with their rank. The bids are not against a particular job, but to give the competing firms preferred supplier status if they are successful.

One director at a subcontractor who had been through the process and did not want to be named said: “It’s causing a lot of problems for us. We simply don’t have the margins to be able to work at these rates.”

He said: “In a meeting Carillion were pretty abrupt about what they wanted. If you weren’t willing to do the e-auction you wouldn’t be able to do the work. We have a lot of work with Carillion and we felt we had no choice. Not unless I wanted to make 10 employees redundant.”

John Denning, director of corporate affairs at Carillion, said: “E-bidding allows for very transparent competition. The good [suppliers] love it because they win.” He says Carillion has no group-wide policy requiring discounts and it selects preferred suppliers on “a myriad of requirements” including health and safety, quality, reliability of delivery and pricing.

So what effect are such practices having? Asking for price cuts began at the start of the recession with housebuilders Persimmon, Taylor Wimpey, Barratt and Bellway wanting cuts of up to 10%. However, outsourcing giant Serco went further in November last year by asking for retrospective rebates of 2.5% from suppliers. It backed down after a storm of bad publicity. And recently Carillion, Balfour Beatty and Interserve signed memorandums of understanding with the government this month to cut the cost of some public work.

As main contractors feel the pressure, other hardball tactics are making a comeback, with suppliers complaining that contractors are holding back retentions on spurious grounds. Payment times are still a problem, with a survey carried out by the National Specialist Contractors’ Council at the end of 2010 showing that four in five firms were waiting on average up to 60 days. Just 4% received payment within 30 days.

Rupert Choat, a partner in law firm CMS Cameron McKenna, says the government, by ramping up pressure on contractors to reduce the cost of public work, may be undermining its own efforts to improve payment practices: “The government seems to be precipitating what we are seeing. The reality is it’s not just going to be borne by Tier 1. A part is going to be passed down the supply chain.”

This pressure on subcontractors comes as the number of construction firms in financial difficulty is already rising. Data from Begbies Traynor Red Flag last month showed a 20% increase in the last quarter to 19,167, with SMEs particularly prone.

Martin Kelly, a director at KPMG involved in restructuring construction firms, said tendering processes were now so competitive that it was now common for rates to be pushed down by a similar percentage to that agreed to by some Carillion suppliers.

He added: “We have been working with 50 firms in the last 18 months and the bulk are specialists. The lower down the supply chain, the more prone you are to pricing pressures.”

So it seems suppliers are once again shouldering more than their fair share of the industry’s pain - and a growing number may not make it.

Read Suzannah Nichol of the NSCC’s analysis here.

Emergency rations

There are a number of lifelines on the way for under-pressure subcontractors - if they can last that long. In November, the government confirmed all firms on public projects must be paid within 30 days. In the same month, it made project bank accounts a requirement of public building projects and is pressing all public bodies to do the same. So far 12, including Crossrail, have adopted them. The new Construction Act, due in October, is also set to improve payment terms and outlaw “pay-when-certified” clauses.

The impact of retentions and e-bidding

Holding a percentage of a subcontractor’s payment pending the correction of outstanding defects is nothing new. But many specialists feel the practice is increasingly a tactic to delay or avoid payment. A director with a well-known subcontractor says: “Contractors have invented defects with no real evidence to warrant claims.” 
E-bidding is also seen as a problem. Many subcontractors believe the virtual system makes bid price the priority, leaving crucial factors such as reputation, quality and deliverability aside. One source claimed e-bidding was fuelling a race to the bottom among specialists.